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392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Presentation on theme: "392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of."— Presentation transcript:

1 392 Money

2 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of settling a debt.

3 394 What is Money? Other functions of Money 1) Medium of exchange 2) Unit of account 3) Store of value

4 395 What is Money? Medium of Exchange A medium of exchange is an object that is generally accepted in exchange for goods and services. Without money, people would have to exchange goods for goods, or barter.

5 396 What is Money? Unit of Account A unit of account is an agreed measure for stating the prices of goods and services. This simplifies value comparisons and purchase decision making if all prices are expressed using a uniform measure.

6 397 The Unit of Account Functions of Money Simplifies Price Comparisons Movie$6.00 each2 six-packs of soda Soda$3.00 per six-pack2 ice-cream cones Ice cream$1.50 per cone3 packs of jelly beans Jelly beans$0.50 per pack2 cups of coffee Coffee$0.25 per cup1 local phone call Price inPrice in units Goodmoney unitsof another good

7 398 What is Money? Store of Value A store of value is any commodity or token that can be held and exchanged later for goods and services.

8 399 What is Money? Money in the United States Today Money in the U.S. consists of: Currency Deposits at banks and other financial institutions

9 400 What is Money? Money in the United States Today Currency is the bills and coins that we use. Deposits are also money because they can be converted into currency and are used to settle debts.

10 401 What is Money? Official Measures of Money 1) M1 consists of currency and travelers checks plus checking deposits. Includes accounts held by individuals and businesses, but does not include currency held by banks, or currency and checking deposits owned by the U.S. government

11 402 What is Money? Official Measures of Money 2) M2 consists of M1 plus saving deposits and time deposits

12 403 What is Money? Official Measures of Money 3) M3 consists of M2 plus large-scale time deposits and term deposits

13 404 Two Measures of Money

14 405 What is Money? Are M1 and M2 Really Money? The test of whether an asset is money is whether it serves as a means of payment. Currency does so Checking deposits are money because they can be transferred by writing a check. M1 is money

15 406 What is Money? Are M1 and M2 Really Money Some savings deposits are readily accessible and can be used as a means of payment. Other deposits are less liquid. Liquidity is the property of being instantly convertible into a means of payment with little loss in value. M2 is money

16 407 What is Money? Other Points Regarding Money 1) Deposits are money but checks are not. 2) Credit cards are not money.

17 408 Financial Intermediaries Financial intermediaries are firms that take deposits from households and firms and makes loans to other households and firms.

18 409 Financial Intermediaries Four Types of Financial Intermediaries 1) Commercial banks 2) Savings and loan associations 3) Savings banks and credit unions 4) Money market mutual funds

19 410 Financial Intermediaries Commercial Banks A commercial bank is a firm, licensed by the Comptroller of the Currency or by a state agency to receive deposits and make loans.

20 411 Financial Intermediaries Commercial Banks Their balance sheet lists their assets, liabilities, and net worth. The assets are what the bank owns The liabilities are what the bank owes These include deposits Net worth is the difference between assets and liabilities.

21 412 Financial Intermediaries Commercial Banks Their balance sheet is described by the following formula: Liabilities + Net Worth = Assets

22 413 Financial Intermediaries Profit and Prudence: A Balancing Act Banks attempt to maximize the net worth of their stockholders They earn profit by lending at a higher interest rate than they borrows Lending is risky Banks must be prudent in how they uses their deposits

23 414 Financial Intermediaries Reserves and Loans Banks divide their funds into two parts: Reserves are cash in a banks vault plus its deposits at Federal Reserve banks Loans

24 415 Financial Intermediaries Three Types of Assets Held by Banks 1) Liquid assets are U.S. government Treasury bills and commercial bills 2) Investment securities are longer-term U.S. government bonds and other bonds 3)Loans are commitments of fixed amounts of money for agreed- uponperiods of time

25 416 Financial Intermediaries Savings and Loan Associations A savings and loan association is a financial intermediary that receives checking deposits and savings deposits and that makes personal, commercial, and home-purchase loans.

26 417 Financial Intermediaries Savings Banks and Credit Unions A savings bank (mutual savings bank) is a financial intermediary owned by its depositors that accepts deposits and makes mostly home- purchase loans.

27 418 Financial Intermediaries Savings Banks and Credit Unions A credit union is a financial intermediary owned by its depositors that accepts savings deposits and makes mostly consumer loans. The key difference between savings banks and credit unions is that credit unions are owned by a social or economic group such as a firms employees.

28 419 Financial Intermediaries Money Market Mutual Funds A money market mutual fund is a financial institution that obtains funds by selling shares and uses these funds to buy highly liquid assets such as U.S. Treasury bills

29 420 Financial Intermediaries The Economic Functions of Financial Intermediaries 1)Creating Liquidity 2) Minimizing the cost of borrowing

30 421 Financial Intermediaries The Economic Functions of Financial Intermediaries 3) Minimizing the cost of monitoring borrowers 4) Pooling Risk

31 422 Financial Regulation, Deregulation, and Innovation Financial Innovation Financial innovation is the development of new ways of borrowing and lending. Primary aim is to increase the profit from financial intermediation

32 423 Financial Regulation, Deregulation, and Innovation The three main influences on financial innovation are: 1) Economic environment 2) Technology 3) Regulation

33 424 Financial Regulation, Deregulation, and Innovation Financial Innovations Variable interest rate mortgages Widespread credit card usage Rise in the importance of the Eurodollar Paying interest on checkable deposits

34 425 How Banks Create Money Reserves: Actual and Required The reserve ratio is the fraction of a banks total deposits that are held in reserves. The required reserve ratio is the ratio of reserves to deposits that banks are required, by regulation, to hold. Excess reserves are actual reserves minus required reserves.

35 426 How Banks Create Money Creating Deposits by Making loans in a One-Bank Economy Lets see an example of how banks create money.

36 427 Reserves$100Deposits$400 Loans$300 Total$400Total$400 Creating Money at the One-and-Only Bank Balance sheet on January 1 Assets (millions of dollars) Liabilities (millions of dollars)

37 428 Reserves$101Deposits$401 Loans$300 Total$401Total$401 Creating Money at the One-and-Only Bank Balance sheet on January 2 Assets (millions of dollars) Liabilities (millions of dollars)

38 429 Reserves$101Deposits$404 Loans$303 Total$404Total$404 Creating Money at the One-and-Only Bank Balance sheet on January 3 Assets (millions of dollars) Liabilities (millions of dollars)

39 430 How Banks Create Money The Deposit Multiplier

40 431 How Banks Create Money Creating Deposits by Making Loans with Many Banks Lets see how the banking system creates money

41 432 The Multiple Creation of Bank Deposits The sequenceThe running tally Deposit $100,000 ReservesLoansDeposits $25,000 $75,000$25,000 $75,000$100,000 Loan $75,000 Deposit $75,000 Reserve $25,000 Loan $56,250 Reserve $18,750 $43,750$131,250$175,000

42 433 The Multiple Creation of Bank Deposits The sequenceThe running tally ReservesLoansDeposits Deposit $56,250 Loan $42,187 Reserve $14,063 Deposit $42,187 $43,750$131,250$175,000 $57,813$173,437$231,250

43 434 The Multiple Creation of Bank Deposits The sequenceThe running tally ReservesLoansDeposits $68,360$205,077$273,437 Loan $31,640 Reserve $10,547 and so on... $100,000$300,000$400,000

44 435 How Banks Create Money The deposit multiplier in the United States differs from our model economys for three main reasons: 1)The actual required reserve ratio is smaller than the 25 percent used here. 2) Banks sometimes choose to hold excess reserves.

45 436 How Banks Create Money The deposit multiplier in the United States differs from our model economys for three main reasons: 3)Not all loans made by banks return to them in the form of reserves.

46 437 Money, Real GDP, and the Price Level We are going to study the effect the money supply has on real GDP, the price level, and the inflation rate.

47 438 Money, Real GDP, and the Price Level The Short-Run Effects of a Change in the Quantity of Money Lets study how a change in the quantity of money effects these factors by examining the aggregate supply-aggregate demand model.

48 439 Short-Run Effects of Change in Quantity of Money Real GDP (trillions of 1992 dollars) Price level (GDP deflator, 1992 = 100) AD LAS SAS AD 1

49 440 Long-Run Effects of Change in Quantity of Money Real GDP (trillions of 1992 dollars) Price level (GDP deflator, 1992 = 100) LAS 113 AD 1 SAS 1 AD 2 SAS 2

50 441 Money, Real GDP, and the Price Level The Quantity Theory of Money The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level. This theory is based upon the velocity of circulation and the equation of exchange.

51 442 Money, Real GDP, and the Price Level The Quantity Theory of Money The velocity of circulation is the average number of times a dollar of money is used annually to buy goods and services that make up GDP.

52 443 Money, Real GDP, and the Price Level The equation of exchange states that the quantity of money (M) multiplied by the velocity of circulation (V) equals GDP, or MV=PY

53 444 Money, Real GDP, and the Price Level We can convert the equation of exchange into the quantity theory of money by making two assumptions: 1)The velocity of circulation is not influenced by the quantity of money. 2)Potential GDP is not influenced by the quantity of money.

54 445 Money, Real GDP, and the Price Level Assuming this is true, the equation of exchange tells us that a change in the quantity of money causes an equal proportional change in the price level.

55 446 Money, Real GDP, and the Price Level This equation shows that the proportionate change in the price level equals the proportionate change in the quantity of money. This gives us the quantity theory of money: In the long run, the percentage increase in the price level equals the percentage increase in the quantity of money.

56 447 Money, Real GDP, and the Price Level The AS-AD model predicts the same outcome as the quantity theory of money. It also predicts a less precise relationship between the quantity of money and the price level in the short run than in the long run.

57 448 Money, Real GDP, and the Price Level Historical Evidence on the Quantity Theory of Money The data are broadly consistent with the quantity theory of money, but the relationship is not precise. The relationship is stronger in the long run than in the short run.

58 449 Money, Real GDP, and the Price Level Correlation, Causation, and Other Influences The evidence shows that money growth and inflation are correlated.

59 450 Money, Real GDP, and the Price Level Correlation, Causation, and Other Influences This does not represent causation. Does money growth cause inflation, or does inflation cause money growth? Does some other factor cause inflation (deficit spending)?

60 451 Monetary Policy NEXT:


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